Companies Shelve Bond Issuance Plans as S&P Again Rattles Market

  • Potential issuance by corporates now off the table: bankers
  • These hybrids can’t be treated akin to common equity, S&P says

At least three companies in Europe have canceled potential hybrid bond sales after S&P Global Ratings revealed plans last month to restrict "high equity content" to certain mandatory convertibles and government-held securities, according to people familiar with the matter.

A European utility was among those corporates readying a hybrid issue with up to 100 percent equity content, the people said who asked not to be identified because the details aren’t public. But this and other deals are now said to be off the table with only one credit rating firm, namely Fitch Ratings, able to assign high equity to such transactions.

"We are in a market where there is appetite for innovation and new structures and there were several issuers keen to explore hybrid instruments eligible to rating agency equity content in excess of 50 percent," said Thomas Flichy, head of capital products at Barclays Plc in London.

Getting equity credit from rating companies such as S&PGR is one of the main reasons why corporates raise hybrid debt, as it flatters their financial and leverage ratios while also supporting equity levels. There has been about 10.9 billion euros ($12.8 billion) of non-financial hybrid issuance so far this year, but the last high equity deal to price was in 2011, Bloomberg data show.

Read more on S&PGR’s request for comments on proposed criteria revisions

The strong level of interest to get higher equity deals done is echoed across the buy- and sell-sides alike. "We were confident that the market was open and we had real interest from issuers and investors," said Arnaud Mezrahi, co-head of capital markets engineering at Societe Generale SA in Paris.

London-based portfolio manager Julian Marks at Neuberger Berman Europe Ltd, whose firm oversees $250 billion of assets, including more than $1 billion in corporate hybrid funds, said he was approached in recent months by three banks wanting "to talk about how it would be structured and potential pricing."

Perfect Moment

The proposed changes by S&PGR will come as a blow to those companies looking to lock in a cheap form of equity and capitalize on investors’ appetite for risk. The cost of issuing hybrid debt has become much cheaper for corporates in recent months, with the differential between senior and subordinated debt ranging from 125 to 175 basis points, down from highs of 300 basis point in August 2016, according to bankers.

"For issuers it would have strengthened their balance sheet, and for investors it would have been an opportunity to secure some extra yield, it would have been the perfect moment for the market," said Julien Brune, co-head of capital markets engineering at Societe Generale SA in Paris.

An example from the intermediate hybrid market, where bonds receive 50 percent equity content, is Spanish utility Iberdrola SA, which priced a 1 billion euro perpetual non-call 5.5 transaction last week with only a 1.875 percent coupon.

Barclays’ Flichy said the desk was using the recent euro non-call 10 Restricted Tier 1 transaction by insurer ASR Nederland NV, which features an equity conversion clause and a mandatory coupon skip mechanism, to illustrate to clients where potential high-equity hybrids may price. That paper currently yields 4.2 percent to the next call date, according to Bloomberg prices.

Orsted A/S -- previously Dong Energy -- was the last corporate to issue a high equity hybrid, but lost the 100 percent equity credit it received for the 7.75 percent coupon notes when S&P altered its methodology in 2013. 

Risky Business

A high equity content bond poses higher risks  for investors than that of an intermediate hybrid, with the former having a mandatory coupon deferral on the event of a downgrade, and the latter having an optional deferral feature under the same circumstances. In case of a default, hybrid investors are also repaid after bondholders and subordinated debt holders.

The risks give some indication as to why S&PGR has proposed changing its criteria, citing that high equity hybrids "differ from common equity in terms of payment and or permanence characteristics."

Moody’s Investors Service also acknowledges the additional risks involved, restricting 100 percent equity credit to mandatory convertible hybrids sold by investment-grade corporates. The agency gives less equity credit to hybrids where losses tend not to be absorbed "unless a broad, company-wide default is imminent," said Carlos Winzer, a senior vice president for corporate finance at the rating firm. 

With only Fitch Ratings now able to assign such high equity treatment for hybrid issuance, bankers predict it will be much harder for corporate borrowers to consider the product at all, even if it’s still technically feasible with Fitch.

Although S&PGR’s proposals have dampened prospects of high equity deals, they are expected to revive issuance of intermediate paper. Under the new proposals, the credit rating firm has said it will stop automatically treating all of a company’s hybrids less favorably if any are repurchased within five years of issue.

Read more on how S&P’s plans may revive a wilted corner of the bond market

Market participants have been given until the end of the month to submit comments regarding the new proposals.

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